Dow's Bid for Rohm and Haas
Harvard case answers...
QUESTION 1 Why does Dow want to buy Rohm and Haas? Was the 78 USD a share bid reasonable?
Part 1: Why does Dow want to buy Rohm and Haas? To discover why Dow wanted to buy Rohm and Haas, we first have to discover the rationale behind the corporate takeover strategy and Dow’s own strategy in general. Andrew Liveris, CEO of Dow, had announced the “Dow of Tomorrow” strategy in 2006, which consisted of two parts.
The first part was the pursuit of an asset-light approach to its low-margin, but cash-rich, commodity business. This was achieved by creating a joint venture (JV) with Petrochemical Industries Company (PIC).
The second part was building high-growth and high-value-added performance businesses. To achieve this, Liveris agreed to purchase Rohm and Maas.
The question remains why Rohm and Haas was such a good target. First, the Haas family agreed to sell their shares (32%). Second, Rohm and Haas would provide a strong operational and strategic fit and an expended network into emerging markets. A lookup of companies active in 2006 by SIC code (Compustat) gives insight into other potential targets. Both Dow Chemical Company and Rohm and Maas have a SIC code of 2821. At the time of formulating the new strategy, Liveris had 16 other companies to choose from in that had the same SIC code (January 2006). One potential reason for the attractiveness of Rohm and Maas for Dow was its size. With a market value of equity of $11billion, compared to Dow’s value of $38billion, the combined entity would by far be the largest in the industry. The third largest company in the industry, after Rohm and Maas and Dow, is Eastman Chemical, with an equity value of $5billion. This shows that the present strategical partners for Dow were presumably too small to have a great impact in the business of Dow. Below is a list of top 10 companies in the same SIC code industry of Dow and Rohn and Maas based on equity value (Compustat: data from 2006 and 2008, excluding Dow and Rohm and Maas).
DOW CHEMICAL ROHM AND HAAS CO EASTMAN CHEMICAL CO HEXCEL CORP SCHULMAN (A.) INC POLYONE CORP OMNOVA SOLUTIONS INC RS TECHNOLOGIES INC CEREPLAST INC ICO INC LUMERA CORP
Market Value of
Market Value of
(x mil $)
(x mil $)
38.226 11.187 4.954 1.633 696 609 192 145 123 93 79
13.948 12.064 2.298 712 291 444 30 88 0 0 21
An interesting find is that, indeed, Dow’s market value of equity shrunk to almost the same value as Rohm & Maas by 2008. Moreover, the shortlist of potential targets shows mostly small targets (compared to Dow and Rohm and Maas). Therefore, based on the available other potential targets, Rohm and Maas is an appropriate strategic acquisition.
Part 2: Was the 78 USD a share bid reasonable? To calculate the full acquisition sum, the number of acquisition shares has to be multiplied by the share bid. In this case, this amounts to $15,23billion. The total deal value (including $3,5billion debt) is $18,73billion and the deal premium is 27% above the 12-month high of Rohm and Maas (74% and 60% above prior day and last month average, respectively). Therefore, by just examining these numbers one can conclude this is very high, at least it is much higher than what the market values Rohm and Maas as a standalone company. Also when looking at how offer prices of usual takeovers are distributed, namely around the 52-week high, Dow’s offer price is relatively far above the average offer price. However, there is a good reason for a higher offer price. The synergy possibilities between Dow and Rohm and Maas are plenty. Besides synergies, the acquisition of Rohm and Maas would change Dow’s earnings profile (increased growth rate, reduced cyclicality) to an “earnings growth company”. Moreover, growth synergies are expected to create $2-$2,6billion in additional present value, and costs synergies are expected to generate $0,8billion in value annually at a cost of $1,3billion (net present value $1,5billion in the first 4 years). Add this together, a range of $3,5-$4,1billion of synergies are possible in the first 4 years. On a per-share basis, this amounts to $17,77-$20,85 and the offer price range without synergies would equal $57,15-$60,23. From Compustat, the 52-week high, prior day value, and last month average are retrieved. The top (bottom) of the offer price range premiums are -1,7% (-6,7%), 34,3% (27,5%), and 24,3% (18,0%), for the 52-week high, prior day value and average last month, respectively. These values are more in line with the distribution of offer prices around 52-week highs. In conclusion, the offer price is very high compared to what normally is paid in acquisitions. However, this is mainly due to the high expected synergies. A valuation without the synergies shows an offer price more in line with the distributions of offer prices.
QUESTION 2 What are the major deals risks inherent in this deal transaction? How and to whom does the manager agreement allocate these key risks? When it comes to mergers and acquisitions, there are some critical factors to consider. The risks involved are not merely financial ones. A failed merger can disrupt work processes, diminish customer confidence, damage the company’s reputation, cause employees to leave and result in poor employee motivation 2
levels. In the next section we describe different major risks inherent in this deal transaction. Based on the information in the case we identified three major risks from a company viewpoint. And two other risks, but we only have limited information in this case.
Major risks Risk of non-performance To control for non-performance there are two termination fees and a specific performance provision. The terminations fees are stated in §7.2a&d. A specific performance is an order of a court which requires a party to perform a specific act, usually what is stated in a contract. It is an alternative to awarding damages, and is classed as an equitable remedy commonly used in the form of injunctive relief concerning confidential information or real property. It is stated in §8.5. Non-performance is addressed by this agreement exclusively in the Delaware Court of Chancery. The provisions for non-performance mainly allocate the risk to Rohm but allow for damages to both parties in case of non-performance. Moreover, based on §5.6 both parties should use there reasonable best effort to complete the terms of the agreement mitigate this risk. The other provisions mainly favor Rohm but allow for damages to be granted to Rohm and Dow.
Risk of delay In paragraph 1.2 the closing date provision is described, by stating a closing date in the contract the risk of delay is mitigated. Moreover, §2.1a is stated that if the merger does not close by 10 January 2009 there will be a ticking fee. This ticking fee of 8% simple interest, controls also for the risk of delay. The risk is allocated to Dow. In paragraph 5.6 is stated that each party shall use its reasonable best efforts to take all actions to do or assist for the merger. So this condition allocates these risks to both parties to complete the deal before the specified closing date. The part described in b &e favors Rohm and holds Dow responsible with respect to any intentional delays in finalizing the acquisition.
Risk that the transaction is valuated not properly Valuation is a subjective matter, involving several assumptions. Integration of the pre-merger entities is a demanding task and has to be managed skillfully. In this case an incorrect valuation of Rohm’s financial position might have a negative influence on the shareholders of both companies. For this reason in §3.17 there is a fairness opinion, Goldman, Sachs & Co gave an independent opinion about the effect that the consideration is fair to the Rohm shareholders from a financial point of view. This fairness opinion is in the interest of the share- and stakeholders of both companies.
Risk of competitive bids evolving the others buyers In paragraph 5.3 there is a “no talk” or “no shop” clause. This clause is in favor of Dow, it prevents that other additional parties (other buyers) might enter the bidding process. This might drive the price up, Rohm is responsible not to talk or shop to other parties.
Risks of material adverse change of the target In §3.1 there is a Material Adverse Effect clause (MAE). This is a legal provision to refuse to complete the acquisition or merger or financing with the party being acquired if the target suffers such a change. The rationale for such a clause is a means to protect the acquirer from major changes that make the target less attractive as a purchase. In this case it favors Rohm and it holds Dow responsible to act in accordance with the clause.
Risks related to the closing conditions Closing conditions generally provide that the obligations of each party to consummate the transactions contemplated by an acquisition agreement are subject to the satisfaction (or waiver) at the closing of an agreed upon set of condition. §6.1 and 6.2 describe some closing conditions of the merger. It listed five different conditions for example risk of non-approval by shareholders and the risk of non-compatibility of the deal with the interests of European capital and money markets and the risk of non-approval under antitrust law. According to the conditions Dow bears the risks after the merger. All the closing conditions protect the shareholders of Rohm and Dow, these shareholders bear the highest risk.
QUESTION 3 As of early 2009, what should Andrew Liveris (Dow’s CEO) do and what should Raj Gupta (CEO Rohm and Haas) do?
Part 1: Wat should Andrew Liveris (Dow’s CEO) do? The current economic climate created a vacuum of liquidity within the financial markets. The PIC deal of Dow put them in a position of not having enough cash to close the deal with Rohm and Haas. Three options are given within the case: 1. completing the deal at $78 per share either voluntary or forced through litigation, 2. terminate the deal through litigation or 3. renegotiate specific terms. If Dow want to close the deal at $78 per share, they need to raise cash. But due to the PIC deal, there are few options to finance the deal for Dow. First option, financing at liquidity markets, is difficult given the state of the financing markets. Andrew Liveris will try to not cut the dividends, because since Dow has started, 97 years of consecutive dividends has been paid out. Then we have the option to sell assets. Dow will probably not consider to sell any of their assets since it is very probable that it will happen at sale prices. Then Andrew Liveris has the option to do a public offering of shares. He will probably not consider a public offering since this will influence the stock price. Due to the selloff to the announcement of the deal with Rohm and Haas and the market conditions, it will influence the stock price in a negative way. Dow’s stock had dropped to $11 per share, and Dow’s market capitalization had fallen below the market capitalization of Rohm and Haas ($10.7 billion vs. $10.8 billion). So the options are cutting dividends, asset sales and using a bridge loan with a one year repayment term to complete the deal at $78 per share. The bridge loan is quite risky, also because it could influence the credit rating by Moody’s. There are doubts in the capital markets if Dow could comply with the bridge loan’s covenants on cash flows and total leverage ratio. Second option is terminating the deal through litigation. This is a very unlikely and difficult route to let a Judge rule in Dow’s favor and to terminate the deal with Rohm and Haas. Changes in the markets as general market conditions, affecting the specialty chemical industry or the financial markets are not covered in the Material Advers Clause. Dow is required to the Reasonable Best Efforts Clause that they must do everything that they can do in their power to complete the deal. Since Dow is unwilling to suspend its dividend and/or issue another public offering of shares to raise cash, Dow is not making a Reasonable Best Effort. Last option is to delay and/or renegotiate the deal. Dow can negotiate with K-Dow (the Kuwaiti entity who terminated their agreement) and other lenders. Dow is planning to sue K-Dow to recover the breakup fee from their failed deal. This breakup fee could be used to fund the deal, or Dow could use this breakup fee as leverage to renegotiate the deal with K-Dow and raise more cash. 5
Another option is to delay the deal which would allow Dow to negotiate for a bridge loan. Dow may try to extend maturity of the bridge loan, but the cost would likely rise and the banks have to be willing to extend the loan. Finally, Dow can look for other longer-term financing options or the credit markets may open up with more time. The third option would be the best considering the options Andrew Liveris has. Since the second option is very unlikely to succeed and the first option is not good for the financial position of Dow Chemicals. Considering above the first two options are not real options for Andrew Liveris.
Part 2: Wat should Raj Gupta (Rohm and Haas CEO) do? As for Raj Gupta, he has the fiduciary duty to the shareholders of Rohm and Haas and so Raj Gupta must do what is in the best interest of the shareholders. He must try to complete the deal with Dow at $ 78,- per share. If Dow blows up the deal with Rohm and Haas, the share price would drop below the initial $ 44,83 pre-announcement price, due to the changed market conditions. So it is vital for the shareholders that the price of Dow is the selling price. Therefore Gupta should force Dow to complete the deal with or without litigation. The deal don’t give the Rohm and Haas’ shareholders any shares of Dow and so Gupta doesn’t have to take into account if Dow can or cannot afford the deal they closed. Since Dow refuses to make their best effort to raise capital or to cut dividends, suing Dow would be a smart choice. Completely opposed of Dow it would be their best option. Gupta has a compelling case when he points out that Dow didn’t make Reasonable Best Effort. In the summer of 2008 the Delaware Court (the same court that would hear the Dow and Rohm and Haas case) heard the case of Huntsman Corporation vs. Hexion Specialty Chemicals. The court ruled against the Hexion, which was the acquirer, forcing Hexion to complete the deal it agreed to earlier. Though Hexion argued that Huntsman had experienced a material adverse effect, the court did not rule in Hexion’s favor and stated that Hexion did not use its Reasonable Best Effort to complete the merger agreement. So with the shareholders best interest in mind and precedent that the Delaware Court would favor the target company in mind, Raj Gupta should pursue the first option and have the deal completed at the agreed price of $78 per share or otherwise force Dow through litigation.
QUESTION 4 If you were the judge (the honorable William. B. Chandler III) in the Delaware Court of Chancery, how would you resolve this legal dispute? The Delaware Court of Chancery is one of three constitutional courts in the state of Delaware. As the court states itself, it is “...widely recognized as the nation’s preeminent forum for the determination of disputes involving the internal of the thousands upon thousands of Delaware corporations and other business entities”. This implies that the court has to obligation to the public to follow the rules stated by the law and act accordingly when asked to do so. Furthermore, this has to be done in a manner that is transparent and consistent with previous rulings. When the courts fails to do is, the authority of the court will be questioned and that is, eventually, detrimental for all people in the society. With that being said, the contractual terms in the merger agreement that Dow Chemical Company and Rohm and Haas have both signed, plays a very important role in the ruling of this dispute. The goal of such contractual terms is to provide clarity when needed. In this case, the need of clarity could be the result of the two parties disagreeing or when an event takes place that would have effects on the outcome of the acquisition. It would undermine the very existence of the contractual terms and merger agreement to make exceptions to or bend the rules and terms in this contract. We therefore think that the court should follow the contractual terms as found in exhibit 4. This means that the court should enforce the specific performance clause of the merger agreement. This will force Dow to consummate the merger at the price which both parties have agreed upon. The price paid will be $78 per share with a ticking fee of 8% per annum, starting of January 10, 2009. The monetary nature of the transaction of this deal make specific performance the appropriate order. The court should also set a date before which the deal must be completed. Besides that, both parties agreed to “..use its reasonable best efforts to take all actions and to do or assist in doing all things necessary, proper, or advisable to consummate the merger.”. This means that Dow has various options to raise capital to complete the deal. Examples are cutting dividends, sale of asset, issue a secondary offering to raise equity or use a bridge loan. It is probable that Dow will state that Rohm experienced a “Material Adverse Effect” (MAE). However, exhibit 4 is very clear on this specific subject; “A “Material Adverse Effect” means such state of facts, circumstances, event, or change that has had a material adverse effect on the business, operations or financial condition of Rohm, but shall not include: a) events or changes generally affecting the specialty chemical industry or generally affecting the economy or the financial, debt, credit or securities markets..”. In this case, there is no event that had an adverse effect on the business, operations or financial condition of Rohm. The event affected the whole economy and the MAE-clause would therefore not stand in court. 7
Concluding, the sole goal of the contractual terms in the merger agreement is to give us guidelines in disputes like this. The court should follow these contractual terms and force Dow to consummate the acquisition using the specific performance clause.